The impact of proposed tax, benefit and minimum wage reforms on household incomes and work incentives

On 8 July 2015, Chancellor George Osborne delivered the first Budget of the new all-Conservative administration, implementing a number of changes to taxes and benefits proposed by the Conservative party during the 2015 General Election campaign. These included increases in the income tax personal allowance and higher rate threshold, restrictions in tax relief on pension contributions and an increase in the inheritance tax nil-rate band for homeowners. Furthermore, full details of the Conservatives’ promised cuts to social security benefits and tax credits were outlined for the first time, including a four year freeze on most benefits received by those of working age, substantial reductions in the amount of support provided through working tax credit and, in future, universal credit to low-income working families and, for new claimants and new births, limiting the child element of tax credits and universal credit to two children. But these are not the only changes to the tax and benefit system that will be introduced over the next few years. A number of reforms announced during by the previous Conservative-Liberal Democrat coalition government during its period in office were not fully implemented by May 2015, and are now set to be implemented by the current government. The most important of these is the integration of six working-age benefits and tax credits into universal credit: a very significant change to the structure of the benefits system for those of working age. These changes will all have an impact on household incomes, and on the incentives individuals face to enter paid work or increase their earnings, and these changes will have different impacts on different people depending on their income levels, family circumstances, age, disability status, housing tenure and consumption patterns, since peoples’ tax liabilities and benefit entitlements depend on all of these factors.

Another important change that was announced in the July 2015 Budget was the introduction of a ‘National Living Wage’ (NLW, a higher minimum wage for those aged 25 and over) from April 2016, to reach 60% of the median wage by April 2020 (£9.35 an hour under current forecasts). The Office for Budget Responsibility estimates that overall this change will reduce national income by 0.1% as a result of fewer hours being worked. Thus, although some households will see their incomes increase as a result of being paid more per worked, others will lose out, either because they are no longer employed at the higher minimum wage rate, they face higher prices from firms having to pay the NLW to their employees or they see lower returns on shareholdings as a result of lower company profits. The gains to workers as a result of receiving a higher wage can be calculated relatively easily, but it is more difficult to ascertain which households will lose out. In this report, as well as showing the direct impact of tax and benefit changes on household incomes and work incentives, we analyse the distributional impact of the gains from the NLW, the impact of the NLW on the work incentives faced by those whose wages are currently below the level of the NLW, and how the introduction of the NLW affects the work incentives of those currently not in paid work to take a job at the minimum wage.